Impending double dip, pressing transformation, slowing banks: “Outdated financing concepts are of little help now,” says Ralf Ehret, partner and head of debt advisory at enomyc. They are often suboptimal, unstable, and not designed for the current risks or future needs of German SMEs. It is no surprise that alternative sources of financing are now booming. But what do companies need to anticipate now in order to act early, honestly, and smartly? A look at worst-case scenarios and dream scenarios from a debt advisor.
Mr. Ehret, you have been familiar with the financing landscape for more than 25 years, are a trained banker, and are now a debt advisor. How do you perceive the current financing climate?
As very cautious, uncertain, and strict. Banks and credit insurers are acting very cautiously. The weak economy, geopolitical situation, and customs barriers make planning extremely difficult. This also unsettles companies. After all, they don't know what will happen next either. In addition, we are experiencing a historic structural transformation that we have never seen before in this form.
You mean the upheaval in the automotive industry.
Yes, Germany's key industry, which has been the main source of our prosperity, together with the closely interlinked mechanical engineering sector: this industry is not just experiencing an economic downturn – it is undergoing a structural transformation. That is the backdrop against which everything is happening. Companies are hesitant to make major investments. At the same time, however, they need funds to drive their transformation forward and keep their old equipment up to date. Germany's economy is approaching a double dip. In certain industries, it is no longer simply a matter of cutting costs.
But what then?
It's about questioning the entrepreneurial business model: a structural crisis requires companies to change key parameters. That is cost-intensive. At the same time, it is unclear whether this approach will work. Companies don't have multiple attempts at their disposal: they need to consider now where they are headed and what is necessary to get there. They also need to ask themselves what a transformation will cost them and whether they can afford it at all.
This is where financiers usually come into play.
However, banks have significantly tightened their lending criteria. They are demanding far more information from companies than usual—in some cases, sensitive plans that companies are not yet able to provide. And how could they? Real planning has never been as difficult as it is in the current environment. For traditional industries, such as manufacturing, this is an extremely uncertain time. Banks are particularly reluctant to lend to companies they consider too risky. They are also very skeptical of new, untested business models. All of this limits financing options, especially for hard-hit industries.
As a debt advisor, you place particular emphasis on analyzing the liabilities side of the balance sheet. What role does this play specifically in financing transformation processes and new business models?
Without liquidity, there can be no transformation. Transformation can be costly and must be financed—either with equity and/or debt capital. That is a challenge. If companies have promising ideas or products and want to transform themselves, they need an extremely good plan that they can present to financial partners. The key questions here are: What do we need? How do we want to finance it? How much equity capital can we contribute? How much capital do we need from the bank? And can our company bear the cost? The first thing to do is to draw up a two- to three-year plan, which can then be used to determine the financing requirements.
You have seen numerous plans and balance sheets of medium-sized companies. What do you think is missing?
Generally speaking, the right timing. In most cases, companies take real financing measures far too late. In many cases, I also miss a clean set of figures. Companies need to plan their figures seriously, track their liquidity, and not just let everything run its course. Companies need leading indicators in their business planning. However, I often find that the liabilities side has not been sufficiently audited or is outdated. Controlling is sometimes not set up well enough, still using Excel lists instead of professional planning systems. But if integrated planning and appropriate controlling systems are lacking, companies risk a high susceptibility to errors. In these cases, external expertise must be brought in to create transparency and solid planning in the first place. This is very time-consuming.
What other weaknesses do you see on the liabilities side?
That some SMEs archive their loan agreements instead of reviewing them on an ongoing basis. However, in addition to interest rates and repayment terms, these agreements also contain binding loan clauses, known as covenants. These limits must be monitored continuously. A covenant breach gives banks the right to terminate or renegotiate loans. However, many SMEs only take action once contractual obligations have already been breached and loans are at risk – often far too late to ensure orderly refinancing.
Why is that? Are these companies simply underestimating their situation?
Yes, and they often plan too optimistically with their house bank. They believe that the bank will simply extend their existing loans and that will be that. But that's not how it works. And then companies come back from meetings with the bank very surprised. They are annoyed by the numerous questions and information that the bank requests for review.
For example, no entrepreneur likes to submit a statement of assets; this is a very sensitive area. Banks have never requested such information before. This is now angering many entrepreneurs. Overall, it becomes emotional, and friction arises for the first time.
What is the consequence?
In many cases, this delays the entire process. It is particularly tragic when companies receive a rejection from their bank after weeks of discussions. Then valuable time has been wasted. If the company's liquidity is no longer sufficient, the situation can quickly become dangerous. That's why the first thing I check in a “passive side audit” is how much liquidity is still available – and also how long it will last if the basic economic conditions remain unchanged, i.e., if sales remain constant. Companies currently operating in a zero-growth economic environment are, at best, maintaining their sales. However, many have overcapacity due to stagnation, which in turn puts pressure on prices. This is where things get really dicey.
You keep mentioning the time factor. How long does it usually take for a company in such a situation to obtain refinancing?
It can't be done within a few weeks. Bank negotiations on expiring loans or new financing take between three and nine months. If loans are due at the end of June next year, a company must start structuring what it needs from the banks – and also what plans it has to present to the banks in a corresponding financing application – in the fourth quarter of the current year at the latest. I have seen cases where credit lines were due to expire in less than four weeks and the existing bank refused to extend them. The company thus risked having its credit lines canceled, reduced, or even terminated. Termination is the maximum penalty and must be prevented. And a company in a difficult situation cannot do this alone.
Is debt advisory catching on among German SMEs?
What has long been the norm in large corporations, because they can naturally afford it, is now also catching on among German SMEs—albeit slowly.
How often do companies actively approach you in a timely manner?
In very rare cases. Most have a commercial management team that believes it can still obtain refinancing or financing on its own. That is why many still decide to go it alone at first.
But is this attitude also changing?
Yes, companies are now also turning to us – less on their own initiative, but because their bank has signaled that it will no longer provide them with unlimited refinancing. Some banks then explicitly recommend debt advisory services, because with this expertise, companies have a much higher probability of obtaining financing. In one case, this happened nine months before a credit line expired. The bank informed the customer that it wanted to be replaced. I was given the mandate and found alternative financing within six months. This customer was lucky, because not every company receives such a wake-up call. Many only come forward when there is a covenant breach and restructuring begins. But then a company has only limited scope to turn the situation around. The time window is then very small to bring alternative financiers on board.
It seems that companies with conventional financing structures are increasingly reaching their limits. You mention alternative sources of financing. Which ones do you currently recommend and why?
There is no one-size-fits-all solution. Financing is always tailored to the individual company. But what everyone needs is a stable financing structure. Banks also have a legitimate interest in this. The most important players in the current refinancing market include family offices, mezzanine capital, specialized private debt funds, and various forms of asset financing. I place particular emphasis on the latter when looking at the balance sheet: What assets does the company own? How are they valued? What rights—such as land charges—already encumber them? Companies can, for example, address leasing issues: they can borrow against goods, land, buildings, machinery, or equipment. This is similar to the sale-and-lease-back financing method. In this way, companies create short-term liquidity without restricting the use of their assets. This method is currently considered one of the best ways to release capital quickly and without affecting the balance sheet.
What was the worst case scenario in your career so far?
In one case, the client concealed the fact that he had violated the withdrawal restriction. Apart from the fact that this was a clear breach of contract, the company lacked liquidity during the crisis. To make up the difference, the bank would have had to be called upon again via its overdraft facilities. That is exactly what I try to avoid as a debt advisor. It is only human to sweep actions you are not proud of under the carpet. But companies should definitely come clean with their debt advisors. As a debt advisor, I am neutral. That is the big advantage, because I can remove the guilty party from circulation until I have reached a clarification with the banks. But to do that, I need prior knowledge. And time. In another case, a financed customer used the loan to finance a third-party company abroad. This is also a grossly negligent breach of credit agreements. It is considered credit fraud. Unfortunately, such cases are not uncommon and can have dramatic consequences for all involved—from financial losses for the banks to criminal consequences for those responsible.
What, on the other hand, is the ideal scenario?
I always want to be aware of the challenges a company is facing before the bank does. Debt advisory should take place before discussions with the bank—and, of course, long before there is a breach of contract. Sadly, that is usually the reason why debt advisory is called in. In nine out of ten cases, however, it tends to be too late by then. The ideal scenario is also an alert German SME sector: companies that know their contracts, review them regularly, and check their loan agreements. Companies should urgently realize that the economic situation is also difficult for banks. Their focus is not on maximizing profits, but now on risk avoidance.
So you are calling for more understanding for banks?
Yes, I am a trained banker and I would argue that lending should not be taken for granted. Lending requires certain conditions to be met, and these have become more stringent in view of the economic situation. I would urge companies to be aware of this and recognize that Due to the rise in insolvencies, banks are now once again experiencing increased loan defaults. Logically, this makes them more cautious. They actively manage their loan portfolios. This is also underestimated. And if a company only takes action once a bank has already decided to withdraw, then it becomes particularly difficult. Companies should definitely anticipate this.
